Question

Halloween, Inc., is considering a new product launch. The firm expects to have an annual operating cash flow of $8.8 million for the next 8 years. The discount rate for this project is 12 percent for new product launches. The initial investment is $38.8 million. Assume that the project has no salvage value at the end of its economic life.

  

a.	What is the NPV of the new product? (Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, rounded to 2 decimal places, e.g., 1,234,567.89.)

b.

After the first year, the project can be dismantled and sold for $25.8 million. If the estimates of remaining cash flows are revised based on the first year’s experience, at what level of expected cash flows does it make sense to abandon the project? (Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, rounded to 2 decimal places, e.g., 1,234,567.89.)

Answer 1

a.

Compute the present value annuity factor (PVIFA), using the equation as shown below:

PVIFA = {1 – (1 + Rate)-Number of periods}/ Rate

                   = {1 – (1 + 0.12)-8}/ 12%

             = 4.96763976672

Hence, the present value annuity factor is 4.96763976672.

Compute the net present value of the project, using the equation as shown below:

Net present value = (Annual cash flows*Present value annuity factor) – Initial investment

                             = ($8,800,000*4.96763976672) - $38,800,000

                             = $43,715,229.9471 - $38,800,000

                             = $4,915,229.9471

Hence, the net present value is $4,915,229.95.

b.

Compute the estimated cash flow, using the equation as shown below:

Initial investment = (Estimated cash flow + Terminal cash flow)/ (1 + Rate)

        $38,800,000 = (Estimated cash flow + $25,800,000)/ (1 + 0.12)

Rearrange the above-mentioned equation to determine the estimated cash flow as follows:

Estimated cash flow = ($38,800,000*1.12) - $25,800,000

                                  = $17,656,000

Hence, the estimated cash flows are $17,656,000.